July 22, 2015    5 minute read

In Or Out – The Options Greece Has

   July 22, 2015    5 minute read

In Or Out – The Options Greece Has

In a financial climate which even for the strongest European economics is uncertain, the question that arises is whether Greece will be able to pay back the money back that they owe their European counterparts. Or will Europe bear the burden which has been placed on its shoulders. This article aims to analyse the magnitude of the severity of the situation that Greece is in and whether a Grexit would actually be a bad thing for the Greek economy or whether it would be short-term hardship in order to achieve long term gains.

Can Greece maintain its primary surplus?

A primary surplus is defined as the governments tax revenue minus government expenditure excluding payments on it’s on debts. It is effectively a measure of austerity so the bigger the surplus the more austere a government is being and in general the unhappier the citizens will be. Throughout Greece’s four year bail-out plan, it has managed to turn its 10 percent deficit into a 3 percent surplus, however this has drastically impacted on the economy such as a large number of jobs lost. The plan demands that Greece manage to reach and maintain a surplus of 4.5 percent which is frankly an untenable position for Greece as can clearly be seen by historical data. Germany only managed to reach its peak of 3 percent twice in two non-consecutive quarters. The Kiel Institute found that it is almost impossible for any country to hold a primary surplus of over 5 percent for long periods of time which is where the interest in whether Greece can pay back the money it owes comes from.

Can Greece repay the money?

The IMF reports that in order for Greece to repay all the money that it owes it would have to run a primary deficit of 7.2 percent for over a decade. That is a somewhat far-fetched prediction because as the public have seen that level of austerity would surely maim the Greek economy in the future. So what is more important to prevent the Grexit is the fact the Greece needs to be able to regularize it’s debt and manage it effectively. This is because National Debt is barely ever completely repaid there is always a deficit which one country is running to another. As long as there is demand for the debt then it can be run endlessly but the problems arrive when the demand collapses and interest rates rise, which comes back to the ability to service the debt.

The effects of a Greek exit for Greece

The first obvious effect would be that Greece would default on its debts which would be because it couldn’t service its debt and pay the interest on it. This would be followed by Greece trying to re-denominate its debt into a new national currency, which for this article can be called drachma V2. Contrary to some suggestions there wouldn’t be much point in overprinting the current Greek Euros because they would just implicitly overnight turn from euros to the new currency. Now the obvious point of this would be to reduce the value of the Greek currency which would lower the cost of output and exports in terms of other currencies overnight.

However as good as that sounds it would be up to the government to stop these positive steps being cancelled out by wage rises and price rises, if they can do this then inevitably there will be an increase in aggregate demand because (X-M) is a constituent part of AD. The increase in the price of imports compared to exports would mean Greece would be encouraged as a country to substitute expensive foreign products for domestic ones. Conversely it would also encourage foreign firms to buy more Greek products because of how they would be cheaper with the new currency. This all sounds great for Greece but the fact is that although in the long run this seems to be a worthwhile option there would remain the fact by leaving the Eurozone and returning to an independent currency it has pitfalls such as the fact it will have less support from the other Eurozone countries if it needed another bailout. Obviously Greece’s economy failing would affect the other countries in Europe but they wouldn’t be as concerned because it wouldn’t be affecting the Euro.

The effect of a Grexit on the rest of Europe

Greece constitutes only 2 percent of the GDP of the Eurozone and so there may not be much of an impact straight away, or at least a big enough effect to be noticeable. So the impact if there was one might not be huge but there could be other ramifications such as the other Eurozone countries becoming even closer so as not to be picked off by the stronger countries once they decide they should also be ejected from the Eurozone. The growth of Europe may also be affected because although there will be more stability for Greece their instability could potentially be almost transferred back to Europe. However most believe that because the threat has been there for some time now the rest of Europe has been somewhat ring-fenced. There is also the fact that people backing the Eurozone are backing Germany not Greece.

So to conclude many believe that Greece leaving the Eurozone could be good for their economy in the long run and might get them out of the current constant borrowing cycle, but it seems an unlikely proposition as if they were going to leave they probably would have done it by now.

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